For Social Security, a Birthday Makeover: Chile's Way

August 23, 2010

Over the next two decades, 78 million Americans will quit working, quit paying into the Social Security system and start drawing benefits, straining the resources of our public pension system. Is there a way to persuade them to stay in the labor force -- continuing to contribute their skills and talent -- and postpone their Social Security payments, asks Estelle James, a senior fellow with the National Center for Policy Analysis?

Yes, there is, and Chile is showing us how, says James:

Sixty-two percent of Chilean men ages 60 to 69 were still in the work force in 2004, compared with 46 percent of American men that age.

Among men ages 70 to 74, 31 percent of Chileans were still working, but only 19 percent of Americans.

Why the difference?

Chile has a public retirement system, but after retirement age -- 65 for men, 60 for women -- people who keep working are no longer required to contribute to a pension fund.

This increases their net wages, strongly encouraging them to continue working.

Since 1981, when Chile put the system in place, labor force participation rates for men ages 65 to 70 have risen 13 percentage points.

Chilean public pensions are set up differently from Social Security, explains James:

Workers contribute 10 percent of their wages to an individual account and choose a fund in which to invest it, earning a market rate of return.

In retirement, workers can receive inflation-protected annuities or withdraw the money gradually.

Workers can receive payments early (and stop contributing), once their retirement accounts are large enough to provide a pension that is at least 70 percent of their average wages and 150 percent of the government-guaranteed minimum benefit.

But a man under age 65, or a woman under 60, who has not reached this target replacement rate cannot receive benefits -- and therefore must keep working.

In contrast:

Americans can start receiving Social Security benefits at age 62, but if they keep working, they must keep contributing.

And if they earn more than a minimum amount, they also see a reduction in their current monthly benefit.

Both the early pension option and the earnings penalty discourage work.